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S&P 500 Index falls 1% on earnings fears, overseas news

Success in investing doesn’t correlate with I.Q. once you’re above the level of 25. Once you have ordinary intelligence, what you need is the temperament to control the urges that get other people into trouble in investing. – Warren Buffett

What looked like a flat week for stocks turned ugly on Friday as the major stock averages succumbed to heavy selling pressure. The S&P 500 Index dropped 1% as worries resurfaced over the Greek debt situation and fears that Greece may default on its obligations and exit the euro zone. News from China also cast a pall over the market as the Chinese adopted new trading regulations that restrict margin trading and expand the use of short-selling stocks. These moves may have been designed to cool a red-hot Chinese stock market as the Shanghai Stock Exchange Composite Index has risen 32% in 2015. While both of these occurrences are plausible reasons for the Friday sell-off, the mere fact that profit-taking took hold with the Dow over 18,000 and the S&P 500 over 2,100 are more likely explanations. Since the beginning of the year, the market has traded sideways, with resistance occurring at these levels with stocks unable to advance and make new highs. Expectations for the first quarter earnings season are also low with profits forecast to drop about 4%. Although most of the companies that reported earnings last week were in the financial sector, the quarterly results were surprisingly upbeat. Among the big money center banks and investment houses, JP Morgan Chase, Wells Fargo, Citigroup and Goldman Sachs all managed to beat analysts’ earnings estimates. This week promises to give investors a better read on the earnings picture as a broader, more diverse group of companies are scheduled to report. However, a steady dose of softer than anticipated economic data may be weighing on investors’ minds and could negatively impact these earnings reports and company outlooks as well. Until the economic data becomes decidedly positive and the outlook for corporate profit growth follows suit, the market is likely to trade in a fairly narrow range.

Last Week

Although March retail sales rose 0.9% and registered the strongest gain in a year, they were lower than forecast. Excluding automobile sales, which were particularly strong, retail sales were only up 0.4%. Both the producer price index (PPI) and the consumer price index (CPI) increased 0.2% in March. A combination of a strong dollar and weak global demand should help keep inflation in check for a while. While home-builder sentiment improved in April due to low interest rates and better job growth, housing starts were lower than expected in March. Leading economic indicators in March were also weaker than expected and jobless claims last week were higher than expected, both indicative of softness in the economy.

The price of oil jumped to almost $56 a barrel, the highest level of the year, as there were reports of declines in production. Other reports suggested that storage tanks are filling up rapidly and that the U.S. is running out of storage facilities, a sign that the price of oil could fall.

For the week, the Dow Jones Industrial Average dropped 1.3% to close at 17,826 while the S&P 500 Index fell 1% to close at 2,081. The Nasdaq Composite Index lost 1.3% to close at 4,931.

This Week

Existing home sales and new home sales for March should both be at levels that are consistent with an improving housing market. Durable goods for March are expected to rise almost 1% after dropping more than 1% in February.

Greece faces a self-imposed deadline this week to create the necessary reforms needed to receive additional aid. Standard & Poor’s recently downgraded Greece’s debt to CCC+.

This week should be a good test for the market as a number of prominent companies from all sectors are due to report earnings. Among those on the calendar include IBM, Google and Microsoft in the technology sector, Verizon and AT&T in the telephone utilities sector, Amgen, Eli Lilly and Abbott Labs in the health care sector, Coca-Cola, Procter & Gamble and PepsiCo in the consumer non-durables sector, McDonald’s in the consumer cyclical sector, Du Pont in the materials sector and Caterpillar, 3M and GM in the capital equipment sector.

Portfolio Strategy

Since the beginning of the year, the S&P 500 Index has struggled to make any headway as it has traded in a fairly narrow band of between 2,040 on the downside and 2,120 on the upside. This sideways action has produced a year-to-date return of slightly over 1%, less than the return on safer and less risky bonds and bond funds. While the vast majority of companies that have reported first quarter earnings so far have topped expectations, the earnings season is still early and has been dominated by financials. A more accurate picture of corporate earnings health will come over the next three weeks as a wide range of companies will report. Beyond the first quarter, the stock market faces a number of headwinds that could potentially limit its upside. Among these are the probability of a Federal Reserve interest rate hike, continued strength of the dollar and its negative effect on exports and overly optimistic profit expectations in the face of weak global economies. With the possibility that U.S. large cap stocks continue to tread water, it’s imperative that investors diversify their portfolios by including both small and mid-cap stocks as well as international equities. Small and mid-cap stocks have generally outperformed large cap stocks as they have not been affected as much by the strong dollar since their sales tend to be more domestic. International equities, including those of emerging markets, have been the clear winners this year with returns in excess of 10%. In developed markets such as Europe and Japan, stocks have benefited from easy monetary policies, favorable currency comparisons and lower valuations. With U.S. large cap equities struggling to find direction, proper diversification among all asset classes can not only reduce the risk of a portfolio but also improve the return as well.